Microeconomics 1–Final.

Question 1

December 14, 2021

Each questions carries 20 marks. The marks for each subpart is indicated in brackets after the
statement of the question.

1. Consider the following questions.

(a) Suppose an individual’s intertemporal preferences are represented by the utility function
u(c1 , c2 ) = min{c1 , c2 }. Income in period 1 is m1 = 100 and in period 2 is m2 = 80.
Interest rate is r = 0.1. Assume that prices in both periods are 1. Calculate the
consumer’s optimal consumption levels in the two time periods. (6)
(b) How much does the consumer save or borrow in period 1? (2)
(c) Now consider a problem of uncertainty with two states of nature, “good” and “bad”.
The probability of the good state is 0.9 and that of the bad state is 0.1. In the good
state, the agent has an asset of value 100 while in the bad state, the asset’s value is 50.
Insurance is available at a premium of 0.12 per unit of insurance.
The agent’s utility function for consumption at the two states is u(cG , cB ) = min{cG , cB },
where cG and cB are consumption levels during the good state and the bad state respec-
tively. How many units of insurance does the agent buy? (7)
(d) In part (b) of this question, is insurance fair? Does the agent buy complete or incomplete
insurance? Do you notice anything unusual about this answer? If so, what? Explain
and give reasons behind your answer. (5)

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 Microeconomics 1–Final.
Question 2

December 14, 2021

Each questions carries 20 marks. The marks for each subpart is indicated in brackets after the
statement of the question.
4 2
2. Consider a production function f (L, K) = L 5 K 5 . The price of labour (L) is w = 4 and the
price of capital (K) is r = 1.

(a) Suppose K = 243 is fixed. Find the associated short run total cost function C S (Q; 243),
where Q is quantity of output. (5)
(b) Find the long run cost function C(Q). (8)
(c) At what Q will C S (Q; 243) = C(Q)? What is the relation between the two cost functions
at all other levels of Q? (4)
(d) Is the long run average cost increasing or decreasing? What does it imply about returns
to scale? (3)

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 Microeconomics 1–Final.
Question 3

December 14, 2021

Each questions carries 20 marks. The marks for each subpart is indicated in brackets after the
statement of the question.

3. Consider the following questions.

(a) Suppose there are 140 firms in a competitive industry. 60 of them are type 1 firms
having a short run cost functions c1 (q) = q + 2q 2 + 32 while the other 80 are type 2 firms
having a short run cost function c2 (q) = q + 4q 2 + 32. The market demand function is
QD = 820 − 40p.
Find the short run equilibrium price and quantity in this market. How much does each
firm produce at this equilibrium? (12)
(b) Consider the same industry with market demand function QD = 820 − 40p. Suppose the
long run cost function is C(q) = 18q − 2q 2 + 0.5q 3 . Find the long run equilibrium. (8)

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 Microeconomics 1–Final.
Question 4

December 14, 2021

Each questions carries 20 marks. The marks for each subpart is indicated in brackets after the
statement of the question.

4. Consider a monopolist with cost curve C(Q) = cQ, for some c > 0. Now suppose the marginal
cost goes up by 4.

(a) If the monopolist faces a linear demand curve, by how much does the price increase?
(10)
(b) If the monopolist faces a constant elasticity demand curve with elasticity −2, then by
how much does the price increase? (10)

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 Microeconomics 1–Final.
Question 5

December 14, 2021

Each questions carries 20 marks. The marks for each subpart is indicated in brackets after the
statement of the question.

5. Consider an exchange economy with two goods, 1 and 2, and two consumers, A and B. The
utility functions of the two consumers are

uA (xA A A A B B B B
1 , x2 ) = 2x1 + x2 , uB (x1 , x2 ) = x1 + 2x2 .

(a) Suppose the endowments of the two consumers are (ω1A , ω2A ) = (12, 12) and (ω1B , ω2B ) =
(0, 0). Will there be any exchange at this endowment? What will be the consumption
level of the two consumers at the equilibrium corresponding to this endowment? (4)
(b) Suppose the government redistributes the endowment levels to make it less unequal.
Thus, the new endowments are (ω1A , ω2A ) = (9, 9) and (ω1B , ω2B ) = (3, 3).
Argue that consumption levels (xA A B B
1 , x2 ) = (12, 7) and (x1 , x2 ) = (0, 5) can be sustained
in a competitive equilibrium. What price vector (p1 , p2 ) will sustain this competitive
equilibrium? In finding this price vector, normalize p2 = 1. (10)
(c) Consider the same endowment as in part (b). Find the price vector such that consump-
tion levels (xA A B B
1 , x2 ) = (12, 5) and (x1 , x2 ) = (0, 7) can be sustained in a competitive
equilibrium. Again, normalize p2 = 1. (6)